Rate cuts in Latin America have become less widespread

In September, there were monetary policy decisions in 29 of the 33 countries we monitor, with rate reductions in 4 emerging economies and a rate hike in Canada.

The countries that reduced their policy rates were: Peru (by 25-bps, in line with expectations), Indonesia (by 25-bps, while maintenance was expected), Brazil (by 100-bps, in line with expectations) and Russia (by 50-bps, in line with the consensus). Canada, on the other hand, hiked the policy rate by 25-bps, while markets were expecting rates on-hold.

Therefore, the number of central banks reducing interest rates remained above the number of central banks increasing the policy rate.

In October, we expect the European Central Bank to announce a reduction in the pace of QE purchases from EUR 60 billion to 40 billion per month in the first half of 2018. In Latin America, well-behaved exchange rates and spare capacity still leave room for monetary easing. In Brazil, we expect a moderate reduction in the easing pace, from 100-bps in September to 75-bps in October, in line with the BCB's recent communication. We also expect an additional 25-bp rate cut in Peru, ending the easing cycle. In Argentina, Chile and Colombia, we expect the central banks to maintain the policy rate.

3. Monetary policy in LatAm

The Argentine central bank is clearly uncomfortable with the current level of core inflation (19.7% annualized using the average of the last three months). So, the Argentine central bank stayed on hold in September, leaving the monetary policy rate unchanged at 26.25% for the sixth consecutive month. Meanwhile, the monetary authority pledged to continue draining liquidity through interventions in the secondary market for short-term sterilization bills (Lebacs). The inflation for the month of September will likely be above the goal targeted by the central bank for the last quarter of the year: 1% per month, a level, in the central bank’s view, consistent with meeting the 2018 target (10% ± 2%). With this background, the president of the central bank, Federico Sturzenegger, affirmed that there is no room, at all, to ease the monetary policy in the coming months. We do not expect changes in the reference rate this year as the central bank reiterates that it is committed to its ambitious inflation targets. We also recently adjusted our forecast for the reference rate by yearend 2018 to 20% (from 18% previously).

In Brazil, the Monetary Policy Committee (Copom) will meet again on October 25-26. We forecast a 0.75 p.p. reduction in the Selic rate for this meeting, in line with the Copom’s recent communication. As usual, the BCB's 3Q17 Inflation Report updated the inflation projections under different scenarios. The forecasts are below the target for both 2018 (4.5%) and 2019 (4.25%) and suggest that the Copom sees room for a Selic rate below 7.0% before ending the easing cycle. Our new inflation forecast at 3.8% for 2018 indicates that the BCB’s forecast may drop further, reinforcing the implementation of additional monetary stimulus. Following the 0.75 p.p. cut in the Selic rate in October, we anticipate 0.50 p.p. cuts in December and February 2018, with the Selic rate reaching the final level of 6.5%.

A united board of the Chilean central bank voted to hold the policy rate at 2.5% in September. The decision was expected, but the unanimity differs from the previous two meetings at which Pablo Garcia opted for a 25-bp cut. Overall, the minutes are in line with the baseline scenario outlined in the 3Q Inflation Report (IPoM) published only a few days before the meeting. The central bank’s base case sees rates on hold for a prolonged period, with inflation in the short-term staying low but not hampering the convergence to the 3% target in the 2-year forecast horizon (as output gap is set to gradually narrow). The central bank has not closed the door entirely to more easing if downside risks to inflation materialize and affect the target convergence trajectory. Nevertheless, we no longer expect the board to the lower policy rate from the current 2.5%. The decision by Mr. Garcia to abandon his call for a cut, the little conviction shown by other members of the board for the need to ease policy further and recent activity recovery lead us to believe that the likelihood of more easing has significantly diminished.

Colombia’s central bank left the policy rate unchanged at 5.25% in September, after a 250-bp easing cycle that began December last year. The decision was expected by most market participants and was in line with our call. The board voted 5-to-2 in favor of holding the policy rate, with the minority opting for a 25-bp reduction, which compares to the three-way split decision in August that saw the policy rate lowered to 5.25%. The two votes for a 50-bp rate cut in August are likely from the same members who favored further easing in September. The press release announcing the decision indicated that the real interest rate is near to its neutral level, but noted that the space for an expansionary monetary policy (that is, real interest rates below neutral) will depend on incoming data (including the current account deficit). We expect the central bank to keep monetary policy at 5.25% until the end of the year, as inflation picks up in 4Q17. However, with lower inflation in early 2018 and a still sluggish economy, we expect the central bank to resume the easing cycle as early as the first quarter of the year, taking the policy rate to 4.5% in 2018.

Mexico’s central bank (Banxico) is on-hold, but watchful of the looming risks. As was widely expected, Mexico’s central bank left the policy rate unchanged (at 7.0%) at the September monetary policy meeting. The statement accompanying the decision suggests that rate cuts are unlikely, at least anytime soon. In the concluding remarks of the statement, the central bank continues to cite the relative monetary policy between Mexico and the U.S. as a relevant variable for the upcoming decisions, which – given the high likelihood of further monetary policy tightening in the U.S. – poses an obstacle to interest rate reductions in Mexico. The board also pledged to monitor the impact of the recent earthquakes on prices, although as stated at the beginning of the press release announcing the decision, the impact is expected to be small and temporary. As in previous statements, the central bank noted that, given the present risks, it will be “vigilant to maintain prudent monetary policy in order to strengthen the anchorage of inflation expectations”, hinting at a cautious stance. Our base case is that the policy rate will be kept at 7%, at least until the beginning of 2H18. We reaffirm our view that Banxico has no appetite for cuts, considering the risks associated to NAFTA, the upcoming elections and monetary policy in the U.S. in a context of solid growth and an interest rate within a range consistent with neutrality. In fact, a number of board members have already expressed this, both in policy documents (minutes) and public remarks.

Peru’s central bank (BCRP) is about to end its modest easing cycle. The BCRP decided to cut the reference rate in September (to 3.50%, from 3.75%), looking through a temporary inflation shock (“lemonade effect”, combination of sharp increases in lemon prices and regulated water tariffs) which caused an inflation spike in August. The statement featured two relevant changes; namely, less benign views on inflation and a tweak of the easing bias (forward guidance sentence). Regarding the inflation outlook, the board now expects headline inflation to stay within the tolerance range around the 2% target in 2017 and 2018, rather than both headline and core inflation (ex-food and energy) converging to the 2% target by the end of 2017 (as it was mentioned in the previous statement). Moreover, the statement eliminated the explicit mention of inflation expectations and activity as the variables that would condition the next rate decisions. Instead, the easing bias sentence is now stated in more loose terms, reading “the Board is especially watchful of inflation and its determinants to consider, if necessary, additional modifications of its monetary policy stance”. Judging from past decisions, we note that the BCRP usually turns the guidance more vague when it is about to end an easing (or hiking) cycle. We expect the reference rate to be reduced to 3.25% before the end of 2017; that means one more 25-bp cut (probably in October) vis-à-vis market expectations of no more cuts (as per the latest BCRP survey). Looking into 2018, our base-case is that the BCRP will opt to leave the reference rate unchanged at 3.25%, to avoid compromising the recovery. In parallel, however, it is likely that the BCRP will continue attempting to loosen monetary conditions in foreign currency. In fact, foreign currency reserve requirements were lowered again in October (to 40%, from 41% in September), for the sixth time in the year (down from 70% in December), in response to the recent rise in U.S. Treasury yields. To be sure, the tightening of USD financing conditions is particularly worrisome for BCRP policymakers because the Peruvian economy is partially dollarized (30% of credit to the private sector is denominated in USD).